INo.CC.Chapter5.Indirect taxes, Subsidies, Price controls. Katherine Wang

The effect of an indirect tax on the demand for, and supply of, a product

Indirect tax

• One imposed upon expenditure.
• It is placed up the selling price of a product
• Raises the firm’s costs
• Shifts the supply curve for the product vertically upwards by the amount of the tax
• Less product will be supplied at every price.

Specific tax

• Specific, or fixed amount of tax that is imposed upon a product.
• Shift the supply curve vertically upwards by the amount of the tax

Percentage tax

• Valorem tax
• The tax is a percentage of the selling price
• The supply curve will shift upwards vertically and tilt according to the price.

Essential questions:

• What will happen to the price that the consumers pay?
• What will happen to the amount received by the producer?
• How much tax will the government receive?
• What will happen to the size of the market, and so employment?

Demand curve & Supply curve after taxation

• The market is in equilibrium, with Qe being supplied and demanded at a price of Pe
• After the tax of XY per unity is imposed, the supply curve shift vertically upwards from S1 to (S1 + tax)
• Producers want to raise the rice to P2, and so pass on all of the cost of the tax to the consumers.
• Problem occurs: Excess supply happens and the price has to fall until a new equilibrium is reached, which is at a price of P1, where Q1 is both demanded and supplied.
• The price of the product for consumers rises from Pe to P1, which is their share of the tax
• Half of the whole tax of XY
• Producers now receive C per unit, after paying the tax of XY to the unity.
• The government will receive tax revenue and that the market falls in size from one producing Qe units to one producing Q1 unit.
• Implications for the level of employment in the market, as firms might employ fewer people
• The burden of the indirect tax is shared fairly evenly between the consumers and the producers.

HL info

• The share of the tax burden for consumers and producers will vary with the relative value of price elasticity of demand and supply for the product.
• The government revenue and the effect on the size of the market also will be affected

First situation:

• The price elasticity of demand is relatively elastic and price elasticity of supply is relatively inelastic
• PED > PES
• The producers cannot pass on a lot of the burden of the tax, because the demand is very elastic and too many of the consumers would stop buying the product
• Major implications for level of employment in the market
• The burden of the indirect tax is much heavier on the producers than on the consumers

Second situation:

• The price elasticity of demand is relatively inelastic and price elasticity of supply is relatively elastic
• PED < PES
• The producers can pass on a lot of the burden of the tax, because demand is fairly inelastic and few of the consumers would stop buying the product.
• Major implications for level of employment in the market
• The burden of the indirect tax is much heavier on the consumers than on the producers.

• PED = PES for a product, then the burden of any tax imposed will be shared equally.
• PED > PES for a product, then the burden of any tax imposed will be greater on the producers of the products than on the consumers
• PED < PES for a product, then the burden of any tax imposed will be greater on the consumers of the products than on the producers.
• Government tend to place indirect taxes on products that have relatively inelastic demand, such as alcohol and cigarettes.
• Demand changes by a proportionately smaller amount than the change in price.
• Government revenue will gain high revenue and yet not causing a large fall in employment

The effect of a subsidy on the demand for, and supply of, a product

• Subsidy
  • An amount of money paid by the government to a firm, per unit of output.
• Lower the price of essential goods to the consumers
  • The government hopes the consumption of the product will be increased, encouraged by the lower price
• Guarantee the supply of products that are necessary to the economy
  • It may be because the goods are essential for the economy ex. basic food supply, power sources such as coal
  • Or the industry creates a lot of employment that would be lost, thus causing economic and social problems
• Enable producers to compete with overseas trade
  • Protect the home industry
• If subsidy is granted to a firm on a certain product, then the supply curve for the product will shift vertically downwards by the amount of the subsidy.
• Reduces the costs of production for the firm, and more will be supplied at every price
• Percentage subsidies are sometimes granted, they are rare
• Mostly specific subsidies.

Demand curve & Supply curve after subsidies

• After the subsidies of WZ per unit is granted, the supply curve shift vertically downwards from S1-S1-subsidy
• The producers lower their prices and increase output until a new equilibrium is reached
• The price to consumers continues to fall, not the whole amount of the subsidy.
• The income of the producers rises from the original amount
• The total income of the producers rises, the total consumer expenditure may increase of fall depending upon the relative savings and extra expenditure
• The money has to be found from somewhere and so there is an opportunity cost her
• The government must either take money away from other areas of expenditure, or it must raises taxes.
  • The opportunity cost of government spending on the subsidy in terms of other alternative government spending project
  • Whether the subsidy will allow firms to be inefficient, if they do not have to compete with foreign producers in a "free market"
  • Because subsidy allows consumers to buy products at a lower price, then they may also be taxpayers who are funding the subsidy, Who is paying the taxes?
  • What damage will it do to the sales of foreign producers who are receiving subsidies from their government.

Price controls

• Maximum prices
  • There is a situation where the government sets maximum price, below the equilibrium price, which then prevents producers from raising the price above it.
  • "The ceiling"
  • Usually set to protect the consumers and they are normally imposed in markets where the product in question is a necessity/merit good
  • It creates problem such as excess demand
  • Shortage may lead to the emergence of a black market, where products are sold at a higher price, somewhere between the maximum price and the equilibrium price.
  • Queues developing in the shops and producers may start to decide who is going to be allowed to buy.
  • The government can attempt to shift the supply curve to the right until equilibrium is reached at the maximum price.
    • The government could offer subsidies to the firms in the industry to encourage more produces
    • The government could start to produce product themselves
    • If the government had previously stored some of the products, then they could release some of the stocks onto the market.

Minimum prices

• The government sets a minimum price, above the equilibrium price, which them prevents producers from reducing the price below it.
• "The floor"
  • Attempt to raise incomes for producers of goods and services that the government thinks are important
  • To protect the workers by setting a minimum wage, to ensure that workers earn enough to lead a reasonable existence.
• The excess supply creates problems
• The government would normally eliminate the excess supply by buying up the surplus products, at the minimum price, thus shifting the demand curve to the right and creating a new equilibrium
• The government could then store the surplus, destroy it, or attempt to sell it abroad. However, the storage tend to be rather expensive and destroying products is considered to be wasteful.
• Selling abroad is always an option, but it often causes angry reactions from the foreign governments involved, who claims that products are being dumped on their market and will harm their domestic industries.
• There is bound to be an opportunity cost whenever government spend money in any given area.
• The cost of buying up and storing surplus must be paid and so the government may well have to cut back on expenditure in some other area.
• Producers could be limited by quotas
• The government could attempt to increase demand for the product by advertising or, if appropriate, by restricting supplies of the product that are being imported, through protectionist policies, thus increasing demand for domestic products.

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Summary

This chapter explains the effect of taxation and subsidies has on the economy. The share of taxation and subsidies is not always equally split between the producers and consumers, it depends on the elasticity of the product. In addition, the granting of taxation and subsidies comes with opportunity cost, and potential consequences may happen.

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Questions

1. How are taxation and subsidies split between the producers and consumers?
2. Under what circumstance will the government set a "ceiling" to a product?
3. How is black market developed?
4. Why does the economy of a country disdain "dumped" products from foreign economies?
5. How could economy be adjust back to its equilibrium after the "ceiling" or "floor"?

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Found Awesomeness

https://www.youtube.com/watch?v=NykcR3RhyR4
This video specific explained the effect of subsidies has on the supply and demand curve. It also gives description of how the consumers and producers split the subsidies.


Flinn, Mike. "Redistribution News and Political Cartoons." Redistribution News and Political Cartoons. CartoonStock Ltd., n.d. Web. 11 Nov. 2014.
This political cartoon shows the opportunity cost of giving subsidies to a specific enterprise. By giving subsidies to oil industry, the government must cut off some budget they invest in medicare.

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Original Awesomeness

This picture shows the two common product that government would place tax and subsidy on. Cigarette is the addictive and hazardous, and education is beneficial. So the government would place tax on cigarette and subsidy to education.